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Invest Like a Member of Congress--Legally!

You may or may not have seen the 60 Minutes broadcast late last year exposing insider trading in Congress. The exposé certainly grabbed the headlines. But—as it turns out—all this insider trading on Capitol Hill was LEGAL!

Any one of us could make a fortune in the market if we had inside information. But … if WE traded on that information we wouldn’t get a term in Congress—we’d get a term in jail!

So much for using the Congressional competitive edge!

So how do you implement an investment strategy with an edge? As a professional investor, it’s one of the most common investment questions I hear. And I touched on this a bit in my last article about gambling supermodels.

In my professional experience there is one sure-fire way to get an edge on the market. And it comes down to good ‘ole boring math—or in this case—mathematical expectancy.

Expectancy is what separates investors from gamblers. Playing hunches, forecasts, tips, and special situations makes you a gambler not an investor—unless you’re in the House or Senate.

You may win on occasion, but over time you are going to give it back to the house … guaranteed! Gamblers put money at risk with unknown or negative expectancy.

Investors only put money at risk when there is a known, positive expectancy. And this principal of expectancy is the foundation for systematic strategies that can make you money!

Members of Congress can stop reading now!

Popular wisdom says you should start the year by reading financial forecasts for the year to come. But forecasts are a flawed investment tool because they are based on something unknowable—something with no mathematical expectancy.

So if you’re not a member of Congress who can legally trade on inside information … and you want more of your money working for you successfully … read on.

The Competitive Edge

Normally, a competitive edge is the result of some specialized knowledge. An investor who works within a specific industry often has a deep knowledge base around thier industry or sector. This can give them an edge over another investor who doesn’t have the same insight.

Another example of a competitive edge is High Frequency Trading (HFT). HFT relies on complex algorithms to analyze multiple markets and execute trades at very high speeds. Without massive computing power … the average investor can lack a competitive edge.

Then there are large institutions, sovereign wealth funds, hedge funds and pensions—all of which can literally move the markets.

So how does the average investor play a bigger game and invest with greater certainty? It comes down to systematic “attributes and factors” that build mathematical expectancy.

This approach is often called multifactor analysis or “quantitative analysis”. But don’t let your eyes glaze over if you’re not a “Quant”. In basic terms—this is just a term for using statistical data to get insight on how returns vary.

And the good news is … most of the hard work has already been done for you. Multiple academics and financial professionals have already spent considerable time and resources finding out what works and what doesn’t.

As I mentioned in my last article, What Works on Walls Street, by James O’Shaughnessy is one of the classic books on this topic. It systematically examines factors such as P/E, P/B, P/S and relative strength to determine which single factor or combination of factors produces the best results.

And there are many other examples of “edges” created through the use of “guru systems”. Systems designed to model investment greats like Benjamin Graham, Joel Greenblatt (Magic Formula), and Joseph Piotroski.

I do realize that most people don’t necessarily want the scientific rigor. But these systematic approaches to investing are invaluable. And for the non-statistician … they have “built in” mathematical expectancy.

You can implement investment models into your portfolio with minimal effort. And you don’t have to follow the herd mentality and hope a strategy or plan will make you money.

By adding mathematical expectancy … you can increase the certainty of your results. I think the hard question for any investor is ... “Do I want to invest for fun and entertainment (like gambling) … or do I want to make money?

Look for my next articles where I will be breaking down small-cap picks based on multifactor analysis. You can also learn more about model investing at the Portfolio-café. And as always … I welcome the feedback so leave a comment.

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